Fundraising for Business

Okay. Now we are getting to the lifeblood of a startup… Money.
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Funds are the fuel that will enable your startup to grow. Capital supports new hires, product development, research, marketing, IT infrastructure,  and more. One of the largest mistakes I’ve seen with any startup (and I’ve made these mistakes myself, so I should know) is being under capitalized.
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In one specific case, I owned and operated a series of health club franchises called Gold’s Gyms. I had three of these locations in the San Francisco Bay area before changing the name to California Athletic Club and expanding the operations to two more locations.

Eventually the clubs were sold to 24 hour Fitness one of the largest health club chains in the world. Throughout the growth of the operations, I was always under capitalized.  So I went about it by trying to grow the business via pure cash flow.

If any of you have been in the health club business, you might know that generally health club margins are very low. So growing the company out of leftover cash flow proved to be more than the challenge.

Looking back, had I capitalized the clubs correctly from the beginning, expansion would have been much easier and we would have been able to grow much larger. This could have led to more acquisitions, club expansion, and a larger investment in marketing. I’d like you to avoid the same mistakes I made.

Types of financing

There are generally only two types of financing with startups, small business, and creative businesses. The first type is debt financing and the second is equity financing. While there are a lot of variables for each, the important thing to note is that debt financing is a loan that needs to be repaid over a period of time and equity financing is not a loan but rather money traded for ownership of your company.

Depending on the structure of your company, the industry you’re in, the management you have, and the potential for exit strategies (how you and your shareholders will eventually exit the business), either type of financing may apply.

What type of financing will you need? Debt financing or equity financing?

Here are the advantages and disadvantages to each:

Debt Financing
Debt financing needs to be paid back over a period of time and will put a strain on cash flow for early-stage companies. Usually debt financing is best for companies that are already in operation and show revenues, cash flow and possibly profit.

Debt financing can come from a variety of financial entities including banks like Bank of America and Wells Fargo, or other financial institutions like the United States Government, Capital One, Chase and more. Some of the more popular debt financing for early-stage companies comes through friends and family where you might go to people you know for loans to start or run your business.

It’s important to understand your financial model to make sure that you don’t take on too much debt early in the company. We have all heard of companies where the debt was so high that the company could not pay the monthly obligation out of cash flow, and ended up filing for bankruptcy are going out of business.

A strong financial model, built by someone who knows how to help you calculate your projections, we’ll give you measurement on an ongoing basis to make sure that the amount of debt you take on it is serviceable. I have built many financial models and realize that this is some of the most important work in an early stage startup.

So, here are some conditions where debt financing makes sense:

• You have existing customers, revenues, cash flow and a proper business plan
• Your financial statements are strong enough to allow you to approach a bank or other lender
• You have some personal collateral which shows that you have been successful. This could be real estate, or other assets
• Your company has enough cash flow to service the debt, meaning you can repay the obligations on time
• You have taken out other loans and your credit worthiness, credit scores, business credit card, and credit history are strong
• You have friends and family that wish to give you money and you don’t want to give away equity in the company
• You are not able to get equity financing so debt financing is your final choice

Equity Financing

Equity financing and fundraising campaign for raising capital is a trade of ownership in your company for raising money. Equity financing can come from friends and family, government programs, angel investors, venture capitalists or strategic partners, who provide capital to start-ups, early-stage, and emerging companies that show high growth potential.

No matter what the form of equity financing, it is important to understand how much of the company you are going to give away for the amount of cash you will receive. This is calculated via your company valuation. Company valuation is how much your company is worth, as that exact moment in time.

For instance, if you have 10 million shares outstanding in your company, and your company is valued at $10 million, the cost to an investor is one dollar per share. So if somebody wants to buy 10% of your company, they would give you $1 million for one million shares in your company (there is a more complex and exact formula which has to do with pre and post valuation, but will go into that in more detail chapters later).

As you build your company and gain customers and revenue, your evaluation should increase thereby making the original investment worth more money. This is how venture capitalists and angel investors make large amounts of money.

For instance, if we track how Google was originally set up, before the IPO Google’s stock price was $85 per share. As soon Google’s stock opened for trading on the NASDAQ Stock Market, it went to $106 per share and within less than a year’s time, Google was at $466 per share.

However, many of the friends and family, angel and venture investors may have purchased Google stock for a few dollars per share. So you can see how some early-stage investments of equity in Google turned out to be huge gains for Google investors.

It is important that you value your company before approaching any type of outside equity investor. The reason is, the investor will want to know early in the conversation where you value the company. Of course they are also going to want to know about your products and services, management team, market risk and more. I’m assuming here that the company status has already been discussed by the time you’re talking about how much equity to give for the investment.

So your valuation is really the beginnings of negotiation of the price for shares in your company. Even with good business ideas, and great management teams, sometimes entrepreneurs overvalue their companies and investors don’t believe that they can get the return they need so they take a pass.

The key is to be realistic about your valuation and usually this requires some outside help. I’ve helped more than 50 companies value themselves in order to go out and raise capital. There is no set way to get this done because it depends on too many variables including current market conditions. There is no single formula for valuing your company and your industry.

Rather, you should seek help to create a valuation range of low to high. For instance you may set your company’s worth between $3 and $5 million. You will negotiate the exact valuation once you’re having conversations with the potential equity investors.

If the investors are perfect for your company and will add a great deal of value, you might value your company towards the low end to give them a better deal. If the investors are not going to add that much ongoing strategic value, you might value your company a little more towards the high end. Either way, valuation is simply a negotiation.

Realize that investors are trying to get the best possible deal, in other words they want the most equity for the lowest possible price. Your job is to argue for higher valuations so that you give away less equity for the same amount of money.

Other Financing Schemes – Debt Plus Equity

There are some new developments in financing which include a combination of debt and equity. Depending on who you are speaking with regarding your financing, this package might be offered. Again, when taking any debt it is important to understand that you can service the debt and make the monthly payments.

So if the venture capital group offers debt and equity, they have probably already determined that based on your financial model and cash flow, you can afford to pay down the debt.

The equity component will act just like normal equity where you trade some ownership in your company for cash. When speaking with financiers, feel free to ask about the different programs they offer. It’s better that you understand all of the options whether or not they are made available to you. If your startup is in a strong position you might be double to dictate a term sheet that is more in your favor.